Here's what the next recession could look like

Since World War II, the average expansion period for US gross
domestic product has lasted less than five years — and the
current expansion is now in its sixth year. Does that mean we're
due for another recession?

Recessions don't just happen because they are overdue; they need
to be induced by some event.

A 'lesser recession'

In a note Thursday, Dario Perkins of UK-based Lombard Street
Research pointed to
the stock bubble as the most likely cause for an upcoming
"lesser recession."

"Asset prices have risen sharply over the past five years in
response to low long-term interest rates and aggressive central
bank stimulus," Perkins wrote. "This presents an important risk
to the global economy, perhaps the most likely trigger for the
next recession."

He added, on a positive note, that unlike the most recent
economic downturn, the next one would likely only be tied to
stock prices. This is because while
stock values have skyrocketed over the past few years, home
values in developed economies have made modest gains. Though a
stock market crash would be a bad thing, it wouldn't nearly have
the same effect on GDP a housing market crash.

Think dotcom bust, not global credit crisis

Perkins illustrated his point by comparing the effect on GDP from
both the dotcom crash and the subprime-mortgage crisis. During
the
dotcom bust, which didn't affect housing prices, GDP
continued to rise for the most part in the quarters following the
stock market peak.

Lombard Street Research

He also pulls research from the Bank of England showing that
credit trends, while very similar to the trajectory of the
business cycle, have peaks that are twice as large and twice as
long. The worst recessions are those that coincide with a credit
crunch, as in 2009. But we are still in a credit upswing since
then. In other words, the next recession isn't likely to be
accompanied by a credit bust, which will further mitigate the
harm done.

The next downturn will also be protected by the still sluggish
recovery from 2009. That is, there are fewer imbalances, less
systematic risk, less household debt, and less bank leverage.

A more mild recession will be
good for central banks that have limited tools left to respond to
an economic crisis. Interest rates — already near zero — can only
go so much lower, and a very high benchmark would be needed to
justify restarting QE.

Perkins explains:

Suppose, for example, the next recession is caused by the
bursting of a bubble in equity prices. Would QE be able to
reverse such a decline? And if central banks were blamed for
causing this bubble, would they be willing to try to reflate the
bubble with the same policy? Obviously we can only speculate
about this, but it is clear both the Fed and the Bank of England
were anxious to stop doing QE because they were concerned about
its potential impact on financial stability.

In short, while Perkins thinks a stock market crash could cause a
recession soon, the effects will be nothing like those felt in
2009.